Will Individuals Ruin the Stock Market? – Morningstar

Will Individuals Ruin the Stock Market? – Morningstar

The author offers two arguments in support of the case. The first is mutual fund flows. Net inflows into U.S. stocks funds are stronger than at any time since 2004, at $76 billion for the year to date. This contrasts with $451 billion in net outflows over the previous seven years. The second argument is anecdotal. It consists of quotes from optimistic investors and from professionals who dislike such optimism.

I was not sold.

To start, net inflows into stock funds started only recently. Historically, one year’s worth of positive inflows from fund investors has not been a danger sign. In 2008, the stock-market crash occurred after five consecutive years of inflows into stock mutual funds, from 2003 through 2007. Similarly, the 2000-02 decline followed 11 straight years of positive sales, dating back to 1989. For its part, October 1987’s Black Monday was preceded by several years of record inflows.

That makes a sample size of three, which admittedly isn’t much. But that’s three more than the article’s sample size of zero. 

The quotes are more worrisome. That individual investors jumped all over the Twitter IPO signifies nothing. Individuals were also gaga over Facebook in May 2012, and that certainly did not indicate an imminent market top. However, the language used by the article’s sources is a problem. It’s the language of a bull market.  

“‘Frankly, from 2009 until recently, I wanted to stay very conservative,’ said Chris Rouk, a technology sales manager in Irvine, Calif. Now, he said, ‘I want to get more aggressive.”

Or, “Joyce Soliman, a 41-year old attorney in Houston, was another stock-market skeptic, until she got a Charles Schwab statement from her investment advisory firm, Medley & Brown LLC, showing gains of nearly 20% in the first nine months of 2013. Now she is planning to set aside more of her paycheck to invest in stocks.”

Those are indeed words to freeze the marrow of an Internet columnist who has a 90% stock allocation. But it’s hard to know how much weight to put on such information. As with any trend story, the author interviews a great many people, and then uses the material that most powerfully supports the story’s thesis. (This is not a criticism; I’ve done it often myself.) The results are not statistically significant.

The scientific evidence that does exist is less frightening. As the


notes, a minority of individual investors, 45%, are bullish on stocks according to the latest poll from the American Association of Individual Investors. That figure is moderately higher than the long-term average of 39% but not unusually so. In early 2012, for example, bullishness was above today’s level–and that turned out to be a great time to buy stocks, not avoid them.

In short: The article raises a legitimate concern. It is the nature of investing that buyers like an asset at 16,000 that they distrusted at 8,000. It is also the nature of investing that this newly popular asset increases in price until it becomes a poor value. This story suggested that the first instance may be upon us. It did not, however, demonstrate that the second has arrived.


The article posits that where individual investors are now heading, savvy institutional investors have been for years. We are told that “institutions such as insurers fueled a broad [stock] rally by pouring cash into the market.”

The part about insurers may be. I haven’t seen data that insurers became net buyers of stocks in 2009-10–and the article does not provide any–but it’s possible. Such contrarian behavior does not typify institutional investing, however.

Note, for example, this chart from

Pensions & Investments

on the average historical asset allocation by U.S. corporate pension funds. Pension funds had a moderate amount of stocks through the early 1990s, a much higher percentage in the late 1990s, a slightly smaller figure for most of the Aughts, and then a huge drop post-2008 (along with very large gains in both alternatives and bonds). That’s not the chart of a contrarian. That’s the chart of a trend follower.

If you don’t believe me, believe Galla Salganik of Ben Gurion University, who writes in

The Determinants of Investment Flows: Retail Versus Institutional Mutual Funds

, that when compared with investors in retail much funds, owners of institutional mutual funds “demonstrate stronger momentum-driven and herding behaviors.”

Institutional investment managers like to position themselves as being above performance chasing. They are not.

Roll Tide Roll

Another common misnomer is that the mutual fund clients of financial advisors behave differently, in aggregate, than do retail investors who buy from funds directly. Over the years, Morningstar has run various studies examining the cash flow behavior of various fund share classes, and they’ve never shown any clear patterns. When it comes to asset-allocation decisions, flows into directly sold no-load funds have tended to echo flows into advisor-sold A and B shares. (These studies can no longer be done, given how many advisors now sell no-load and institutional shares through fee-based programs, but back in the day they were reasonably accurate.)



‘s piece makes clear why. “At the height of the financial crisis, Mr. Rouk, 45 years old, hired a new financial adviser and asked her to fill his portfolio with bond and cash investments. Now he is asking her to add to his stock allocation.”

Advisors can nudge. They can instruct. They can cajole. Ultimately, though, investors will go where they will. The tide can be resisted but it cannot be reversed.

Thanks, Charlie

Today, memorial services are held for

Charlie Trotter

, who was for two decades Chicago’s leading chef. Per today’s radio announcer, Trotter passed away last week after having helped “Chicago become the world’s leading dining capital.”

Uh … what?

Maybe not. But thank you for your contributions, Charlie. I celebrated my 5th and 10th wedding anniversaries at your restaurant, and those meals were indeed as fine as any I have had. Too bad you weren’t with us for longer. 

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar’s investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own


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